I don't even want to break into one of my rants about stabilizing the global "personal" real estate market. But I will....

Every loan for a persons "HOME" should be underwritten by the government; reason! to provide the economy with a very strong foundation to build upon. A solid middle class foundation of millions of homes.

Of course the Banks can charge a small fee. But the loan is from FreddiMae - The loan for EVERY American will be no higher than 1% above the prime rate charged to banks and a loan will stay at that rate until the loan is fulfilled. In the end WE must have a system in place that will allow a familyt with varying types of credit and income a chance at a HOME. And the capitalists can still make a profit.

A bunch of very numerate people designed and securitized these subprime loans packages, made fat bundles of bonuses for themselves and left the bag to the other less numerate citizens when poop hit the fan.

Numeracy is like money, the poor need a lot more of it while the rich have too much already.

As a mathematician, I am not too surprised at the general level of "innumeracy" amongst the general public. (Although computing compound interest is not really what real mathematicians do for a living!).
What worries me more is the blind belief in mathematical models and formulas to create extremely dangerous (not for Goldman Sachs but for the general public!) financial instruments such as CDO's (even CDO squared) and CDS's. Maybe the investment banks and the rating agencies know that most normal human beings are so "scared" of math that they can just pull the wool over people's eyes to make huge profits. An honest mathematician would never do that, but I do realise that Reality is not Truth. Financial reality is pure perception fueled by greed!

Somebody help me with this logic.
A person bad in mathematics has a greater danger of defaulting than people with better mathematics. Did they try this on gamblers and see where they ended up? And would a gambler good at blackjack be someone who better saves for a rainy day (blackjack being a game of probabilities)?

I reckon you're over-analyzing the subprime debacle while commenting on the demand side of the housing market implosion. We really don't need any sophisticated regression analyses or dense micro-economic modeling to ascertain the variables responsible. Its simple common sense, really. Imagine this scenario - I worked at Taco Bell and made $11/hr and despite having a credit score of 620, I get qualified and go on to finance a brand new Audi TT @ $350 per month. No matter how prudent I might be with my ostensibly meagre income, sooner or later, I'll start missing my payments. Its just that simple. The only math to consider here is - If I make $11 an hour, what in the world I'm doing driving a new Audi! Yes, they shouldn't have qualified me for an auto loan, but perhaps more importantly, I should've been smart enough not to apply for it in the first place

If a homeowner expects have negative equity forever, due to a long-term decline in the value of their house, then the "numerate" thing to do is to default. Bankruptcy is not a terrible thing in the US, and if all it costs a person is their ability to borrow, when borrowing is what got them into trouble in the first place, the "punishment" is a blessing in disguise. The more interesting question, which bankers don't dare ask publicly, is "Why don't more people strategically default?" Logically, in a market where home values have dropped by 50%, which is not uncommon, and in a country where people move every 3 years on the average, waiting for a recover that will make the house profitable to sell simply does not pencil out, as any numerate person could readily calculate.

If the researchers attempted to answer the more important question, I suspect they would find the answer in the peculiar psychology of sunk costs. Many studies have shown that we assign higher value to regaining what we've lost than to obtaining something new, even when both the new thing and the old thing can be equated to hard money. Investors hold on to poorly-performing stocks, hoping that they'll recover, rather than selling them at a loss and buying stocks that are far more likely to gain in value quickly. With houses, homeowners will throw good money after bad, perhaps because they were brought up to believe that defaulting is a sin, but more likely because they don't want to admit that they were foolish to pay so much for the house.

"Subprime borrowers were by definition people of limited means with poor credit histories. "

The hardest thing for economists to do is to be careful when their innate prejudices are in play. If they are a little loosey goosey with their definitions, it's amazing how often their prejudices are 'confirmed'.

Here is an example of not being careful. The actual definition of a subprime loan is different from what the author assumes. A subprime borrower is actually someone whose income and assets are not enough for the loan requested to qualify as a 'prime' borrower.

If one substitutes the first definition for the latter, any analysis, absent the happy coincidence of them happening to refer to the same data set, is totally bogus. This is how so much garbage gets produced in the economics world.

If the authors have evidence that the two different definitions refer to the same data set, than they should produce it. I haven't seen anything to make me believe that they do. Yet, oddly enough, I have seen a ton of stuff put out under that assumption.

The least literate may tend to have the lowest credit scores - and thus fall into the Subprime group of borrowers. The banks (or mortgage agencies) should have known better than to lend to them. Or they did - but expected Uncle Sucker (Uncle Sam) to buy these shoddy mortgages (courtesy of Fannie Mae/Freddie Mac). Thank you to the Congress and Senate for failing to regulate those train-wrecks of mortgage 'banking' - if you can call them that. Thank you Barny Franks (for nothing!) All of our esteemed leadership should be voted out come November - it is the least they deserve! If the same happened in Corporate governance - then they would lose their jobs!

Defense of banks being "forced" to lend to poor risks is a canard designed to shift blame from the predators who wrote these loans. The proof is in the myriad of small and medium banks who have very healthy mortgage business; they didn't get a free pass on the lending laws.

A nurse assistant who worked under me was offered good terms and on the day of the signing 12 points were added to the loan without their knowledge, thinking the contract they were signing was identical to the one they were given to peruse several weeks prior.

This was a common practice that has come to light in a class action out in Washington State where the bait and switch relied substantially on folk's inability to follow complicated formulas that were changed from initial offers on the day of signing.

For my nursing assistant, it was a $100,000 mortgage and, oddly, the points equaled their $12,000 savings which was to be the down payment. (The lender had access to this info from the application) The new terms eliminated the down payment, took the savings for the points and Presto! you have a 0% down loan with an immediate $12,000 profit.

The lender post signing convinced the couple that they now had a much bigger tax deduction and that they were coming out ahead, stupidly writing these figures down as an addendum to a 40+ page document now part of a lawsuit.

This isn't fraud, but damn close. My CNA's lack of understanding to crunch the figures and the last second contract rewriting on the day before moving is all high pressure and deceitful. Business people have ethical and moral obligations to educate their customers and to guide them to make choices that minimize risk and maximize their client's success.

To blame the borrower solely is gross and reveals such in those who defend these lenders as being someone not at all to be trusted.

Well, I always seem to overestimate people's understanding of compound interest. Which is a pretty big concern in an era where deficit reduction is going to be the biggest problem for a lot of countries.

The thesis seems to be that people who have a demonstrated history of not managing their finances may lack math skills. An interesting note is that a Wall Street Journal article from 2007 stated that 2/3 of subprime mortgage customers were prime consumers. They could not get the terms they wanted from a conventional bank. These borrowers were betting on housing prices going up indefinately and were engaging in speculation.

In addition, a massive expansion of the community reinvestment act led to politically motivated loose lending to "poor" consituents from large government run lenders who had political appointments.

Here are a few other factors:
- loans with outrageous structures
- no doc loans (no verification of employment or residence)
- brokers with no stake in the loans
- a voracious appetite from wall street banks, funds, and other entities demanding more of this paper
- investors not paying attention to what their funds were doing
- poor transparency of company's static pool loss trends
- a government sponsored monopoly on ratings agencies, where there was pressure for the agencies to rate the paper AAA by their customers
- Refusal of the senate and house banking committees (Frank and Dodd) to act when the Bush administration brought up concerns in 2002, 2004, and 2006. Ironically, these two politicians are leading the "fix" of the financial system.
- Failure to suspend the mark-to-market rule. Subprime securitizations are thinly traded. The collateral was not worth zero just because the market for the securities was shut down. Banks took giant "paper" losses because of this
- moral hazards were present from the consumer, through the broker, through the lender, through the regulators, through to investors.

The bottom line - everyone involved in this was bad at math. The subprime consumers were the least of the problem here.

Refer to FITCH Ratings annualized net loss index for prime and subprime auto loans. The cyclical nature of the subprime borrower is higher (6% as opposed to 1%), but has been very stable through the last 2 recessions. It was the prime loss index that went to unprecedented levels in this last crisis.

Ah, but the same logic does not hold water when it comes to the really dumb big decisions. I'm certain that there were lots of post-graduate types in the meeting rooms at AIG and Goldman and Lehman and RBS and... But then, maybe I'm confusing intelligence with having a lawyer-MBA qualification?

Sherbrooke, I think FjBuck10 summarized the article exactly: Everything else being supposedly equal, it appears that those less math savy were more likely to fall behind on their mortgage.

Are you then arguing that their is a confounder issue?: That people who are less math savy were more likely to lose their jobs and not be able to get another one? That would be a different explanation than others have voiced here, that, for example, less math savy people make poor spending decisions.

I don't think the article picks the path of possible causality, it just presents a statistical association.

Sherbrook, hedgefundguy, put aside your notions of jobloss and "keeping up with the Jones'" for a moment and consider what the article is suggesting:

"Surprisingly, the least numerate were not making loan choices that differed much from their peers. They were about as likely to have a fixed-rate mortgage as the more numerically able. They did not borrow a larger share of their income. And loans were about the same fraction of the house’s value."

The "numeracy" explanation is fascinating because America's less numerate homeowners, regardless of income stability or social ambition, seem to suffer the woes of the housing bust more than than their more numerate peers. This observation reiterates the critical importance of good math instruction in our school systems.

The next time an ornery student complains, asking, "When will I ever need to know this math?" we all will have a relevant answer for him.